The pandemic highlighted how harmful lease arrangements can be for office, retail, and industrial tenants as lease commitments continued despite interrupted usage of the leased premises. In this article, a group of LPC advisors provide insights into how and why longstanding lease norms protect landlord interests in uncertain times, whilst providing limited protection for tenants. This article and the follow-on articles will help any tenant negotiate a more ‘tenant-friendly’ lease arrangement.
Perspective and power
“The leasing norm is determined by those who control the narrative” - Reminder from the LPC team
When determining commercial leasing norms, the supply side (Property investors, developers, and leasing agents) exert a far more significant influence than the demand side. The main reason for this is that the supply side are collectively focused on preserving asset valuations and related income streams as this is the critical success factor for the business they operate, whilst each tenant’s primary focus is on running their specific business as efficiently and effectively and profitably as possible. For a property investor their business is property, whilst property for the tenant is necessary to accommodate their business.
The supply side is consolidated, connected, well organised and powerful, whilst tenants are fragmented with asymmetrical access to leasing information. In effect, the supply side controls the narrative through their associations, advocacy initiatives, data control, and ongoing communications, aiming to ensure ever-increasing income streams and asset valuations.
The long-standing outcome of supply side power is a set of ‘tenant unfriendly’ norms for leasing arrangements, norms that favour property investors and leasing agents whilst increasing a tenant’s business risk. At LPC we are committed to bringing about changes in the tenant perspective on what a lease is, to facilitate changes to leasing norms so that lease arrangements are more supported of tenant enterprise.
Then came the pandemic
“The only way to have the right stuff come out under pressure is to put the right stuff in” - Anonymous
What the pandemic highlighted for almost all commercial tenants across Australia, is that their lease did not protect them when the utilisation of the leased asset was impaired or interrupted. So it was that commercial tenants in Melbourne had essentially unchanged occupancy cost obligations notwithstanding 263 lockdown days ( https://lockdownstats.melbourne/ ), a consequence of signing a lease agreement that transferred the risks of ownership to the tenant without any participation by the tenant in the benefits of ownership, and with minimal protections relating to diminished utilisation.
The response by government to the pandemic impact on tenancies was to try to enforce landlords and tenants to share the pain of interrupted utilisation of leased premises via the Mandatory Code of Conduct for Commercial Tenancies. Review of the financial results of the major property investor companies, together with our own experiences of negotiating rent relief, evidence that that the legislative intervention did not achieve the intended level of landlord assistance and rent abatement, reinforcing the need to ensure lease terms and are more protective of tenant’ interests. From the perspective of retail, office, and industrial tenants, the ‘right stuff’ was missing from their lease agreements resulting in tenants bearing the risks associated with impaired utilisation, whilst landlords could enforce lessee obligations and call on bank and personal guarantees to minimise loss. Numerous news reports draw attention to the uninterrupted lease obligations significantly contributing to the increasing business insolvencies.
Whilst the cause of interrupted utilisation was different in Christchurch in 2011 and 2012, the earthquakes created a similar tenant outcome with tenants denied access and utilisation of leased premises, in combination with leases that did not provide for rent abatement and termination rights in such circumstances. In retrospective response to the crisis, the Auckland District Law Society standard deed of lease was amended to include clause 27.5 which contemplated specific situations that result in interrupted access, and which provided for proportionate reduction in rent and outgoings. Underpinning the development of this clause was the principle of landlords and tenants sharing in the pain that comes from interruption in the use of the leased asset. This perspective is closer to LPC advisors' viewpoint about what a tenant is buying, although we have a broader view on the factors that impair utilisation.
Perspective matters
“If you change the way you look at things, the things you look at change” - Wayne Dyer
Lease norms stem from the way stakeholders think about a lease. The power and influence of the supply side is such that the generally accepted perspective of a lease is that the risks of ownership are transferred to the tenant for the term of the lease, whilst only the lessor benefits from any increase in the value of the leased asset over the lease term. In practical terms, this implies negotiating lease terms that secure favourable and predictable income streams for the landlord, regardless of the potential for changes beyond the tenant’s control that may negatively impact the tenant’s utilisation of the leased premises. Our view is that if the landlord requires this level of risk transfer, then the tenant needs to share in the increase in the value of the leased asset during the term, for the tenant’s covenant and the lease create value for the landlord. Alternatively, lease terms must ensure utility value is defined and maintained throughout the lease term.
Whilst the pandemic impact on tenant utilisation is obvious, there are numerous more subtle examples of diminished utility value when there is a change in utility or appeal of the leased asset outside of the tenant’s control. We regularly come across tenants disadvantaged by property owner works that diminish the attraction and utilisation of the leased premises during the term, yet their lease does not have appropriate protections for such circumstances. Other examples of impaired utility value include degradation in the leased asset attributes such as foot-traffic, building grade, building services, building infrastructure, and building efficiency, attributes that the Landlord initially marketed to the tenant and influenced the tenant’s decision making. It is all too common that the executed lease agreement does not provide adequate protections for the tenant, such that utility value gets impaired without recompense.
At LPC our starting perspective on a lease is very different to the accepted norm. Our view is that the lessee is buying the right to utilise a leased asset, which the Landlord provides to the lessee with specific landlord guarantees and obligations relating to utilisation, and that any impairment or interruption to utilisation must attract a proportionate reduction in occupancy costs. This perspective drives lease negotiations that focus on the utility value for the tenant of the leased premises, regarding the tenant’s business requirements and risks over the lease term. As Wayne Dyer says, “If you change the way you look at things, the things you look at change”.
Conclusion
In summary, we underpin negotiations with the concept that a tenant is ‘buying utilisation’ of the premises via the lease. In this regard we seek guarantees from the property owners that the attributes that made the premises the preferred choice initially will be sustained, and provisions that amend the occupancy cost when utilisation is impaired for reasons beyond the tenant’s control.
Look out for the next article in this series and all the best with your lease negotiations.
About LPC & the LPC subscription service
LPC provides office, retail, and industrial occupiers with advice and services that make a difference to their accommodation arrangements and respective businesses. With no ties to investor property owners or leasing agents we only represent occupiers, and our advice is free from any conflict of interest that would disadvantage an occupier. You will find the LPC subscription service most beneficial when identifying critical terms for renegotiation and getting to the lease you deserve.
